Surplus Note report - A.M. Best

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U.S. Property/Casualty & Life/Health
Surplus Notes Overview
As of year-end 2014, there were 526 insurance carriers that held over 1,200 outstanding surplus
notes totaling $47.8 billion. In terms of the total insurance industry, the life/annuity (L/A)
segment had the largest holding of surplus notes at $29.0 billion, accounting for 7.9% of the
industry’s total capital and surplus, excluding the asset valuation reserve (AVR). The property/
casualty (P/C)
segment had $14.9
billion in total surplus
notes outstanding,
accounting for
2.1%, while the
health segment
had the smallest
dollar amount of
total surplus notes
outstanding at $3.9
billion, or 2.6% of the
industry’s total capital
and surplus. For those
companies with outstanding surplus notes, the
average percentage of surplus notes to total
capital and surplus was 21.6% for P/C, 13.6%
for L/A, and 63.4% for health (Exhibit 1).
It is important to note that 31% of all
outstanding notes in our population had a
perpetual maturity date. Excluding perpetuals,
the average maturity for outstanding notes was
12.4 years for health companies, 23.1 years
for life companies,
and 21.4 years for P/C
companies (Exhibit
2). Since 2000,
approximately 1,000
notes totaling roughly
$38.7 billion have
been issued. In 2014,
the volume of notes
issued reached a peak
of 160 notes totaling
$5.7 billion (Exhibit
3). Since 2008, the
number of surplus
notes issued per year
has more than doubled,
averaging 97 new
issuances a year. From
2000 to 2008, surplus
Life sector
leads in
surplus note
balances.
Issue Review
November 11, 2015
Analytical Contact
Jason Hopper
+1 (908) 439-2200 Ext.5016
Jason.Hopper@ambest.com
Contributor
Ken Felsher
SR-2015-709
BEST’S SPECIAL REPORTOur Insight, Your Advantage.
Exhibit 1
Surplus Notes by Segment (2014)
P/C L/A Health
Total
Industry
Number of Companies 310 106 110 526
Total Surplus Notes ($ billions) 14.9 29.0 3.9 47.8
Total Capital and Surplus ($ billions) 705.4 365.8 151.2 1,222.4
Percentage of Total Capital (Total Industry) 2.1% 7.9% 2.6% 3.9%
Percentage of Total Capital
(Average - Companies w/ outstanding surplus notes) 21.6% 13.6% 63.4% 16.6%
Source: A.M. Best data and research
Exhibit 2
Average Maturity by Segment
Segment Average Maturity
Health 12.4
Life 23.1
P&C 21.4
Total Industry 20.1
Exhibit 3
Surplus Notes Outstanding by Issue Date
12
24 28
57
62
56 56
34
65
81
93
59
87
136
160
0
20
40
60
80
100
120
140
160
180
0
1
2
3
4
5
6
7
8
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
#ofIssuances
 Number of Issuances Total Per Year (Billions)
TotalSurplusNotes($billions)

2
Special Report U.S. Property/Casualty & Life/Health
note issuance fluctuated, with an
average of 41 notes per year. In
2014, each sector reached a peak
in terms of number of issuances,
with P/C companies issuing 58
notes, L/A companies issuing
22 notes, and health companies
issuing 80 notes. The health
segment saw the most dramatic
increase since 2011 following
relatively constant issuance in
earlier years and a significant dip
in issuances in 2011 (Exhibit 4).
In terms of total dollar amounts
per year, L/A companies led
the way as expected. After the
sharp increase in 2009, there
was a steady decline in the
amount of surplus notes issued
in this segment, declining to a
low of $168.9 million in 2011
and remaining relatively flat
at just over $1 billion for the
subsequent two years (Exhibit
5). In 2014, another significant
increase was seen as totals for
L/A companies rose to $3.4
billion for the year. However,
this was attributable to $2 billion
of surplus notes issued by one
company, Teachers Insurance
and Annuity Association. In
2014, the P/C segment issued
$1.4 billion in notes, which is
the third largest total on record
for one year. Prior to 2008,
health companies did not issue
surplus notes in large quantities,
averaging only five notes a year.
However, starting in 2008,
there were substantial increases
averaging 35 issuances a year. In
2014, there was a new peak of
80 notes issued, totaling $954.4
million, which is the highest
total on record. (Exhibit 6) In
terms of the total dollar amounts
issued for the last 15 years, the
L/A segment comprised 57.9%,
while P/C accounted for 33.3%
and health, 8.7%.
Exhibit 4
Number of Issuances Per Year
Exhibit 5
Surplus Note Totals
Exhibit 6
Health Segment: Surplus Notes Outstanding by Issue Date
 Number of Issuances Total Per Year (Billions)
 # of Issuances Total Surplus Notes (Millions)
0
10
20
30
40
50
60
70
80
90
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
P/C L/A Health
0
1,000
2,000
3,000
4,000
5,000
6,000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
 P/C  L/A  Health
1
4 3 5 4 4
10 7
15 17
24
9
35
67
80
0
10
20
30
40
50
60
70
80
90
0
200
400
600
800
1,000
1,200
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
#ofIssuances
($millions)TotalSurplusNotes($millions)
Exhibit 4
Exhibit 5
Surplus Note Totals
Exhibit 6
0
10
20
30
40
50
60
70
80
90
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
P/C L/A Health
0
1,000
2,000
3,000
4,000
5,000
6,000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1
4 3 5 4 4
10 7
15 17
24
9
35
67
80
0
10
20
30
40
50
60
70
80
90
0
200
400
600
800
1,000
1,200
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
#ofIssuances
Exhibit 4
Exhibit 5
Surplus Note Totals
Exhibit 6
0
10
20
30
40
50
60
70
80
90
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
P/C L/A Health
0
1,000
2,000
3,000
4,000
5,000
6,000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1
4 3 5 4 4
10 7
15 17
24
9
35
67
80
0
10
20
30
40
50
60
70
80
90
0
200
400
600
800
1,000
1,200
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
#ofIssuances

3
In terms of issuance to affiliates,
the insurance industry as a whole
has issued 61.4% of all surplus
notes to an affiliate or parent.
An analysis by segment shows
that 71.1% of health surplus
notes outstanding are held by an
affiliated company, compared to
52.6% within the L/A segment
and 60.5% in the P/C segment
(Exhibit 7).
The average coupon rate for
surplus notes held by affiliated
entities was lower for P/C and
L/A companies. For the P/C
segment, the average coupon
rate was 82 basis points lower for
affiliates at 4.79%, compared to
5.61% for non-affiliates (Exhibit
8). Similarly, for L/A companies,
the average coupon rate for
surplus notes held by an affiliate
was 5.56%, compared to 6.23%
for non-affiliates. However, for
health companies, the reverse
was seen, with the average
coupon rate for affiliates at 4.96%,
much higher than the 1.73% for
non-affiliates. This is mostly due
to the launch and operation of
Health Care Consumer Operated
and Oriented Plans (CO-OPs)
under the Patient Protection
and Affordable Care Act. This
law allowed the government
to finance the startup of these
companies at virtually no cost
to the insurers in order for them
to compete with the established
insurers. With such an easy
access to capital, the health
insurance exchanges as well as
outside companies offering these
plans have issued a large quantity
of surplus notes. Additionally,
2014 had the largest number of
floating rate surplus notes since
2006 based on our population.
Since 2011, the growth of
fixed rate surplus notes has
skyrocketed (Exhibit 9).
Exhibit 7
Surplus Notes Issued to Affiliates vs. Non-Affiliates
Exhibit 9
U.S Surplus Notes - Fixed vs. Floating
 Affiliate  Non-Affiliate
 Affiliates Non-Affiliates
(%)
4.96
5.56
4.79
1.73
6.23
5.61
Health
L/A
P/C
0 1 2 3 4 5 6 7
0
20
40
60
80
100
120
140
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
FloatingFixed
2
2
2
2
2
2
2
2
2
2
2
2
2
2
60.5
52.6
71.1
39.5
47.4
28.9
0
10
20
30
40
50
60
70
80
90
100
P/C L/A Health
Exhibit 8
Coupon Rate of Affiliates vs. Non-Affiliates
NumberofSurplusNotes(%)
Exhibit 7
Exhibit 9
(%)
4.96
5.56
4.79
1.73
6.23
5.61
Health
L/A
P/C
0 1 2 3 4 5 6 7
0
20
40
60
80
100
120
140
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
FloatingFixed
200
20
200
200
200
200
200
200
200
200
201
201
201
201
201
60.5
52.6
71.1
39.5
47.4
28.9
0
10
20
30
40
50
60
70
80
90
100
P/C L/A Health
Exhibit 8
Exhibit 7
Exhibit 9
(%)
4.96
5.56
4.79
1.73
6.23
5.61
Health
L/A
P/C
0 1 2 3 4 5 6 7
0
20
40
60
80
100
120
140
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
FloatingFixed
60.5
52.6
71.1
39.5
47.4
28.9
0
10
20
30
40
50
60
70
80
90
100
P/C L/A Health
Exhibit 8

Published by A.M. Best Company
Special Report
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4
Over the past 15 years, insurance companies have been able to effectively utilize surplus notes
as opportunistic sources of capital. In the last five years, the launch and operation of CO-OPs
has significantly changed the landscape of surplus note issuance not only in the health sector,
but in the insurance industry as a whole. Easier access and better terms on surplus notes has
made it more efficient for health companies to raise capital.
The significant spike in the dollar amount of outstanding notes in 2009 can be attributed to
the effects of the financial crisis and driven by two main forces. First, the capital issuance was
needed to fund additional growth that was not able to be supported by existing capital. The
new surplus note issuances were somewhat concentrated in insurers specializing in annuities,
who reported declining profitability due to their exposure to equity markets through variable
annuity products. This inflow of new capital allowed L/A insurers to maintain capitalization
levels in line with their historical levels despite reporting declining profitability or operating
losses. The second driving force of increased usage of surplus notes stems from the need to
replace capital that had been depleted by losses from existing business and/or investment
portfolios. While it can be said that the economy has been steadily recovering, the continued
low interest rate environment allows surplus notes to remain an attractive option for insurers
to maintain strong risk-adjusted capital.

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